New California Law On Servicing Of Second Mortgages Causes Confusion Among Lenders And Servicers

On June 30, Governor Newsom signed into law AB 130, which includes a new provision to the California Civil Code, Section 2924.13. The new law (previously discussed here) became effective on July 1. The purpose of the law was purportedly to make it more difficult for loan servicers to non-judicially foreclose on so-called "zombie mortgages."

The section of AB 130 that created the new Civil Code provision was an add-on to a lengthy budget trailer bill, and there is no legislative history to fall back on with respect to certain vague or confusing provisions in the new law. After three months of attempting to service junior liens under the new law, loan servicers are discovering that there are problems associated with servicing loans under the new law. For example:

1. The law states that it is an unlawful practice for servicers not to provide borrowers with written communication on the loan for three years. However, does this prohibit the servicer from collecting on the debt if the home is sold after three years?
   • Response: Nothing in the statute states that a debt becomes uncollectible when the statute is violated. Accordingly, even if the lender/servicer has not provided any written correspondence to a borrower for more than three years, the lender/servicer should not be prohibited from collecting on the debt. However, servicers still face a risk that a borrower might choose to seek injunctive relief from a court seeking to prevent proceeds from being distributed to the lender/servicer.
2. Section 2924.13(b)(4) states it is an unlawful practice if "[t]he mortgage servicer conducted or threatened to conduct a foreclosure sale after providing a form to the borrower indicating that the debt had been written off or discharged, including, but not limited to, an Internal Revenue Service Form 1099." Is the intent of the law to include loans discharged through bankruptcy, regardless if they are written off?
   • Response: The language is unclear. It appears to apply to loans written off or charged off; however, as noted, the phrase "or discharged" would appear to include loans that were not charged off. Moreover, even if a loan is charged off, it should not mean the lien is extinguished, i.e., a lender should still have the right to go after the collateral. AB 130 seems to suggest otherwise.
3. In section 4(b) the law states that it is an unlawful practice if "the mortgage servicer conducted or threatened to conduct a foreclosure sale after providing a form to the borrower indicating that the debt had been written off or discharged." Per TILA, once a loan has been charged-off, the lender/servicer will typically stop sending periodic statements after sending a notice tiled "Suspension of Statements & Notice of Charge Off – Retain This Copy for Your Records." Even though the lender/servicer is complying with TILA, does this mean it cannot foreclose since it is providing a form to the borrower indicating that the debt had been written off?
   • Response: While the law is not clear, it appears that once a mortgage lender provides a notice to the borrower pursuant to Section 1026.41(e)(6) of Regulation Z stating that the debt has been written off, the new law will prohibit the lender from thereafter conducting a foreclosure sale on the property.
4. Section 2924.13(c) states the lender/servicer cannot "threaten to conduct a non-judicial foreclosure" until it simultaneously records a notice of default (NOD) and the new "certification" form. If the lender/servicer sends pre-foreclosure notices (required by California law prior to an NOD being recorded), does the new law consider the pre-foreclosure notices a "threat to conduct a non-judicial foreclosure"?
   • Response: It is hard to imagine that sending a pre-foreclosure notice as required by law prior to the delivery of a recorded notice of default would constitute a "threat of foreclosure." It seems like the answer is no. Unfortunately, the law is decidedly unclear.

Putting It Into Practice: These questions likely just scratch the surface of the issues that will arise going forward with respect to servicing junior liens in California. We will continue to monitor the space for developments, but some of these issues may just require a legislative fix.

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